VideoThe American economy is forever blowing bubbles. Housing seems to be the investment bubble du jour, coming on the heels of the Internet bubble, which popped seven years ago. The two are linked: as the dot-com economy slowed, Federal Reserve Board chairman Alan Greenspan steadily lowered the federal funds rate, eventually to a rock-bottom 1 percent. That cheap credit, in turn, fueled a spectacular rise in home prices, greater than any since the years following World War II.
Yale economist Robert J. Shiller charted that ascent in the second edition of Irrational Exuberance, his classic study of the 1990s stock-market boom. Between 1997 and 2006, real home prices in the United States soared more than 80 percent (see "Up, Up, and Away" at the end of this article). Shiller, who famously identified the Internet bubble, thinks irrational exuberance again was the culprit, pointing out that the Federal Reserve had lowered rates before without triggering a housing bubble. He has said that the housing market could drop by as much as 50 percent in the next decade.
Not everyone is as gloomy. Some think the bubble will deflate gently rather than burst, while others continue to question whether the housing boom is, in fact, a bubble at all. Perhaps prices will level off at a new plateau, as they did after the 1940s boom. Or, perhaps, people will soon be recalling another Yale economist, Irving Fisher, who proclaimed shortly before the 1929 crash: "Stock prices have reached what looks like a permanently high plateau."
Bubbles, unfortunately, can be verified only after they burst. There is no academic consensus on the status of bubbles; indeed, economists debate whether it is meaningful to talk about bubbles at all, particularly from a public-policy perspective. ("The Fed cannot reliably identify bubbles in asset prices," said Fed chairman Ben Bernanke in 2002. And even if it could, he added, "monetary policy is far too blunt a tool for effective use against them.") Still, many observers say that speculative bubbles have obvious hallmarks: skyrocketing prices that defy market fundamentals, increasing speculation, participation in the market by people who normally don't get involved in such things, even a tendency to permeate various aspects of popular culture.
Bubbles in the Long Run
Despite the fear and trembling over what certainly looks like a housing bubble, there is a more optimistic way to regard it: as further evidence of a competitive advantage for the American economy. That's the novel view of bubbles offered in a contrarian new book by Daniel Gross, Pop!: Why Bubbles Are Great for the Economy (HarperCollins, May).
Gross is a financial journalist and commentator (and past contributor to CFO) who regularly writes for The New York Times and the online journal Slate, as well as his own blog. A critic of the contemporary business scene and author of previous books on American business history, Gross isn't a Pollyanna; he's well aware of the widespread misery and financial ruin that followed the bursting of previous bubbles. But he writes that while the misery has been amply chronicled, the positive side of bubbles has received little attention. "One can't help but think that the sackcloth-and-ashes approach misses part of the story," he writes.
In Pop!, Gross presents a breezy and highly informative history of major U.S. speculative bubbles, seen mainly from the bright side. He argues that bubbles are ultimately beneficial if they create new commercial infrastructures — such as the telegraph, or the railway system, or the Internet — that enable new businesses to grow and old businesses to transform themselves. Crucially, bubbles also create "mental infrastructures," says Gross, the collective mind-sets that persuade people to change their accustomed ways of doing business — whether sending messages by telegraph, dispatching freight by railroad, or buying and selling via the Internet.
Bubbles, in short, are explosions of entrepreneurial energy that facilitate the rapid rollout and adoption of new technologies. The inevitable excess capacity results in lower prices, making those technologies feasible for general use. Long after the start-up companies have folded and the usual scandals have run their course, the commercial infrastructure remains. Compared with other countries, "we get over bubbles more quickly and do more with what has been left behind," Gross tells CFO.
Thus, by the time the telegraph bubble finally deflated, the United States was wired coast-to-coast and the cost of telegraphy had dropped to a penny per word. The telegraph liberated value from its geographic confines, says Gross, leading to the creation of national financial markets, stock brokerages (originally known as "wire houses"), Dun & Bradstreet, and the Associated Press. Thomas Edison, Andrew Carnegie, and RCA's David Sarnoff were all once telegraph operators, he notes.
The inclination to jump in feetfirst and ask questions later is a signature trait of American business, suggests Gross. True, many early telegraph companies were bad investments and investors lost their shirts, while the rollout of the telegraph in Europe was a more orderly affair controlled by the government. But no pain, no gain: by 1852, the United States had strung up more than 23,000 miles of wire. France, in comparison, had a mere 750 miles.
Reader Comments» Post a comment